On October 3, 2014, the Internal Revenue Service (IRS) issued a Private Letter Ruling (PLR 201440023) that opens the path for charities to monetize their intellectual property through commercial arrangements with for-profit companies. The ruling approves an arrangement between a 501(c)(3) charity and a for-profit media company pursuant to which the for-profit company acquired the right to use the charity’s research and analysis for commercial purposes in exchange for a periodic payment.
The charity, which conducts research and analysis and provides the results of its research and analysis to the public, gave the company the right to use the information to market and sell its services, for research and reporting by its news operation, in development and distribution of its proprietary databases and for educational purposes. The charity requested a ruling from IRS to the effect that the performance of the agreement: (1) would not jeopardize its tax-exempt status; and (2) would not be an unrelated trade or business for which the charity would have to pay taxes. In analyzing the arrangement, the IRS first looked to see if there was excess “private benefit”.
What Does Private Benefit Refer To?
Private benefit, which is prohibited, occurs when a charity does something that confers a substantial benefit on private individuals such as a company’s shareholders. Private benefit may occur in transactions even where the terms are fair and reasonable to the charity. In this case, the IRS concluded that the benefits to the company and its shareholders were merely incidental, because the rights given to the company were crafted to further the charity’s goal of reaching the widest possible audience for its information, were non-exclusive, and did not restrict the charity from distributing the information through other channels, even on a non-commercial basis.
Stressing the fact that the purpose of the arrangement was to further the charity’s goal of reaching the widest possible audience for its content, the IRS said that, “in an educational context, an organization may be determined to be operating for public purposes even if the general public does not have the same direct access to the educational program as does some smaller, restricted group. Although the Agreement will benefit only subscribers to [the company’s] services, the population served is broad enough to warrant a conclusion that the Agreement serves a broad public interest.” Accordingly, the IRS ruled that the arrangement would not jeopardize the charity’s tax-exempt status.
Based on reasoning that the primary purpose of the arrangement was to further the charity’s goal of reaching the widest possible audience, the IRS also ruled that the arrangement was “substantially related” to the accomplishment of the organization’s mission. As a consequence, the organization should not have to pay tax on the income it receives from the arrangement, although the IRS declined to rule on this for technical reasons. The IRS also declined to rule on whether or not the income would be treated as “royalty” income (also exempt from tax) because it did not have sufficient facts to make that determination.
By contrast, the IRS has recently denied applications from groups that involved related charities and companies where the same group of people controlled both entities. In those situations, the IRS has said it must assume that the charity will be used to provide undue benefits to the for-profit company and therefore does not primarily serve a public purpose. While that is a dubious assumption, the fact that the charity and the media company were independent of each other clearly helped in this case.
This PLR is good news for charities, especially in the education field, that produce information, data, or other kinds of content, and license that content to media companies for commercial use. It confirms that the IRS will allow arrangements with for-profit companies so long as the arrangement primarily serves the interests of the charity, the benefits to the for-profit company are reasonable in scope, and the charity does not grant greater rights to the for-profit than it needs to in order to accomplish its mission. That the IRS has finally chosen to make this point in written guidance is equally significant, as it has been unwilling to do so up until now. For practitioners, who have been starved for guidance in this area, this is a large step forward.
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